1 Risky Investment to Avoid at All Costs — and Where to Invest Instead

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As the market continues its slump, stock prices have been reaching new lows over the past several months. While that can be unnerving for many investors, it also means it’s a fantastic opportunity to buy at a discount.

Market downturns are one of the most affordable times to invest because you can load up on quality stocks for a fraction of the price. However, choosing the right investments is more critical than ever because not all stocks will recover from this sell-off.

Although the investments you choose will largely depend on your personal preferences, there’s one investment it’s best to avoid: penny stocks.

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Penny stocks: Risks to consider

Penny stocks are generally defined as any stock priced at under $5 per share, with many costing $1 or less per share. Because of these low prices, they can be especially tempting when you’re investing on a budget.

While price is an important factor to consider when choosing stocks, there are a few risks involved in buying penny stocks:

  • Volatility: Penny stocks can be extremely volatile, experiencing massive price shifts from day to day. While all stocks can face turbulence at times, penny stocks see some of the most extreme ups and downs.
  • Less demand: Before you can sell shares of a stock, there needs to be another investor willing to buy. Because penny stocks don’t have as many buyers, they can sometimes be tough to sell. If you’re unable to sell your stocks and prices plummet, you could potentially lose a lot of money.
  • Lack of information: Penny stocks are generally issued from smaller companies, and that in itself can be a risk. Also, smaller companies often don’t have as much publicly available information, which can make it harder to research these stocks before you buy.

All of these factors combined mean that penny stocks can be incredibly risky. While there’s a chance you could make a lot of money with this type of investment, you could easily lose a lot of money, too.

A safer (and equally affordable) option

The primary advantage of penny stocks is their price, but there’s another type of investment that’s just as affordable: fractional shares.

When you invest in fractional shares, you’re buying a small slice of a single share of a company’s stock. So if you wanted to buy shares of, say, Tesla but can’t afford to spend more than $700 for a full share, you could buy one-tenth of a share for just $70.

The best part about fractional shares is that you choose the price tag. If you can only afford to spend $5, you can buy a very small slice of a share for $5. This also makes it easier to build a diversified portfolio because you can buy dozens of different stocks for under $100.

Fractional shares can also take some of the nerves out of investing — especially when the market is shaky. If you want to invest but are nervous about throwing hundreds of dollars into the market during a downturn, fractional shares can help you ease into it more slowly.

The biggest risk to consider

One thing to remember when buying fractional shares is that it’s still crucial to do your homework when choosing stocks.

It can be tempting to buy stocks from shaky companies simply because they’re affordable, but bad investments are still bad investments. No matter how much you’re spending, make sure you’re only buying stocks from healthy companies with the potential for long-term growth.

Finally, try your best to keep a long-term outlook. Many stocks will take a hit when the market is in a slump, but the strongest companies will perform well over time. With fractional shares, it’s much easier to invest in these businesses without breaking the bank.

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Katie Brockman has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Tesla. The Motley Fool has a disclosure policy.